Financial Ratios

The speaker provides an overview of liquidity ratios.  They determine how agile a company is as far as cash flow is concerned.  She discusses the current ratio and quick ratio and talks through each ratio in detail.

The current ratio is current assets divided by current liabilities.  She mentions that this ratio describes the cash position of a company.  This ratio should be at least 1 and preferably 2.

The quick ratio, or acid/test ratio, is (current assets minus inventory minus prepaid expenses)/current liabilities.  This ratio describes the short term cash position and is very similar to the current ratio; however, excludes some of the more less liquid components.  It is a more accurate measure of te firms liquidity.

The speaker provides a basic overview of many of the key financial ratios that are used for fundamental analysis of a company.  He covers the debt/equity ratio, return on assets, PEG, quick ratio, P/E ratio, EBITDA, and more.  He mentions the importance of benchmarking and using these ratios in the proper context.  You cannot compare the ROE of a manufacturing company against the ROE of a consulting company. 

The speaker provides a basic overview of the return on equity formula and breaks it down into its components.  Return on equity takes net income and divides it by equity.  This formula breaks down into profit margin times equity turnover.  By breaking the formula down into these components, we are able to understand why a companies ROE is high due to their profits or their asset turnover.

The formula can be taken one step further to add a component of financial leverage to understand how much debt the company is taking; this is known as 3 step.  Finally, there is a 5 step calculation which is known as the dupont formula.  This formula is no longer used.